When a principal residence is sold, up to $250,000 ($500,000 MFJ) of the gain can be excluded from income under §121. There are special rules that aply to the sale of a principal residence when part of the residence is used to produce rental income. As of December 23, 2002, the rules changed regarding how taxpayers with rental use of their home report the sale of their residence.
GENERAL RULE
Generally, if the property is used as a principal residence in two out of five years preceding the sale, and the other §121 conditions are meet, the exclusion applies to all the gain except the part of the gain attributable to depreciation taken after May 6, 1997.
MIXED-USE PROPERTY
If property is mixed-use property (part residential and part rental), and it was not used entirely as a principal residence during the five years preceding the sale, the reporting depends on where the rental use takes place. If the rental use takes place within the dwelling unit – defined as a house, apartment, condominium, mobile hom, boat, or similar property, but does not include detached structures, all of the gain is eligible for the exclusion except the gain attributable to depreciation taken after May 6, 1997.
The fact that the principal residence is rented at the time of sale does not necessarily prevent the gain from being excluded under the code. The gain exclusion depends on whether the taxpayer meets the ownership and use requirements and the one-sale-every-two years test at the time of sale. The depreciation allowed or allowable after May 6, 1997, is not eligible for the §121 exclusion.
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When turnkey rental business is strong, we sometimes forget about being frugal, but we all remember the “bad days” of the appraisal recession in the mid-1990s. rental properties
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